Manipulation by any other name

June 27, 2011 05:05 AM

Earlier this month we asked, “Is government manipulation of markets the answer?” in reaction to the release of a study by the United Nations Counsel of Trading and Development (UNCTAD).

Earlier this week the answer from the Obama Administration appears to be “yes” as they decided to open up the Strategic Petroleum Reserve (SPR) along with the International Energy Agency (IEA)to make-up for lost Libyan production. The decision to release 30 million barrels of oil from the U.S. SPR over the next 30 days seems to be a stretch of the emergency role of the SPR and could be an omen of a slippery slope towards more government intervention.

As we noted in a subsequent post on the UNCTAD report, which recommended that central banks take affirmative action to roll back the effect of what it called the “financialization of commodity prices,” part of the reason for higher commodity prices is the use of agricultural commodities in creating biofuels. In the United States the ethanol industry is being subsidized by government so government action is, in part, causing some of the price dislocation the UN is  recommending be solved by more government action.

While the thrust of the UNCTAD report is that it believes speculation in these markets is to some degree the cause of higher prices — a view we do not necessarily subscribe to — it does acknowledge that more traditional fundamentals are playing a role. We continue to ask why all the prescriptions to address the so called problem focuses on the one side of the equation where there is no consensus rather than the side where there is a consensus.

As far as the Administration’s move, it is probably borne more of political considerations than an overall philosophy on markets, but we have seen that bad policy often pushes more bad policy. It is easier for politicians to create policy to address problems caused by other bad policy than simply reverse the original bad policy. This is a slippery slope towards more intervention in markets.

On the other hand, there is a civil war going on in Libya that has affected supply. Though there have been other supply disruptions that did not push us to tap the SPR.

The recent credit crisis proves that regulation is necessary, but the goal of regulation and government policy should be to allow markets to do what they do best. It should not be used to create an outcome, however beneficial that may appear to be at the time. The list of negative unintended consequences for this type of intervention are too numerous to mention.

And while my first reaction to the announcement was positive based on self interest — I am driving to the east coast this week — this doesn’t seem the type of emergency envisioned for the SPR.

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.